Microsoft falls into the broad category of high-quality stocks that were incredibly expensive in 1999 and have not gone anywhere since (and have often declined, as is the case with Microsoft). But most stocks in that category – take Walmart (WMT), Cisco (CSCO), Medtronic (MDT), etc. – have seen their earnings and revenues triple and P/Es collapse. So before we run to crucify the management of these companies and call them “value traps,” we should actually take a careful look at their fundamental performance. Management did what it was hired to do: It increased shareholder value by growing the business while maintaining or increasing the moat. It is the shareholders who overpaid for those stocks in the ’90s. Management is not at fault for that, human greed is.
However, 10 years ago Microsoft was an icon, it was a star, it was the company that any self-respecting software engineer wanted to work for. Today, with current management’s help, it is slowly becoming a has-been. In fact, when I think of Microsoft I often think of a quote from Warren Buffett (Bill Gates’ best friend), who said he wants to own a company whose business is so good and whose moat (competitive advantage) is so wide that it could be run by a monkey, because someday it will be. Buffett, though he’s the Oracle of Omaha and all, probably did not know at the time that he was talking about Microsoft
The moat is still there; Microsoft still dominates in desktops, servers, productivity (office), and even gaming; and that is why, despite Mr. Ballmer’s antics, earnings are much higher today than they were 10 years ago. But when a company is run by a proverbial Buffett’s monkey, no matter how good the business is, the moat will grow shallow and then cease to exist. Even five years ago one would have been fairly comfortable projecting rising Microsoft cash flows 10, 15 years out. That confidence is much lower today.
Microsoft’s past success, $40 billion net-cash balance sheet, and the $20-plus billion in cash it generates each year gives management a false sense of security. But success has it side effects. It takes away the need to be paranoid, competition is dismissed, focus is lost – there is no project (even the touch table) that is not off limits when you think you have limitless resources. Steve Jobs once said that focus is not what you choose to do, it is often what you choose not to do.